Robert Hockett & Saule Omarova—
It is common to claim that finance is about ‘credit-intermediation,’ a matter of channeling funds from virtuous savers to needful end-users. The picture behind this assertion is that of a gargantuan broker—the financial system as ‘go-between.’ But modern financial systems are much more about credit-generation than intermediation. We need a new metaphor.
In our view, a modern financial system is best modeled as a public-private franchise arrangement. The franchisor is the sovereign public, acting through its central bank or monetary authority. The franchised good is the monetized full faith and credit of the sovereign—its ‘money.’ And the franchisees are those private sector institutions that are licensed by the public to dispense, in the form of spendable credit, the franchised good.
Like any good franchisor, a public acting through its central bank works to maintain the ‘quality’ of the good that its franchisees distribute. In the contemporary ‘developed’ world, the quality in question has been understood primarily in terms of over-issuance.
The central bank’s task has been understood, that is to say, in modulatory terms, the primary objective being to prevent consumer and, in some enlightened jurisdictions, asset price inflations and hyperinflations. Allocative decisions, for their part, are thought best left to the market, on the putative ground that the public’s ‘picking winners and losers’ is apt to be ‘politically arbitrary’ rather than ‘financially sound.’
Two conceptual errors, one of them partly corrected since 2008, seem to have hampered the ‘quality control’ efficacy of many central banks and monetary authorities in the pre-2008 period.
The first was the tendency to think of ‘inflation’ as a disease only of consumer goods and services markets but not commodity or financial asset markets. Hence pundits, politicians, and even some central bankers crowed of a ‘great moderation’ featuring 30 years’ low consumer price inflation even as asset and many commodity prices rocketed to previously unimagined heights. The crash was the consequence.
The second error was to think the financial system’s modulatory and allocative challenges mutually orthogonal, such that the former might be handled through leverage-regulatory, liquidity-regulatory, and traditional monetary policy instruments wielded by the franchisor through its central bank, even while leaving credit-allocative functions primarily if not entirely to privately owned franchisee institutions.
While the first error has been more or less widely recognized since the crash of 2008, finding expression in a ‘macroprudential turn’ on the part of central banks and coordinate financial regulators, the second error seems to have remained overlooked. The fact is that without affirmative effort to channel finance capital to the ‘real’ sectors of the economy, glutting toward the financial sectors is all but inevitable, rendering the modulatory task all but impossible. Good modulation requires good allocation.
The reason for this, in turn, is that modern macro-economies are beset by multiple coordination and collective action problems, many of them recursive, in the financial and ‘real’ sectors alike. It can be individually rational, for example, for investors to bet upon and thereby potentially exacerbate short-term price movements in secondary financial and tertiary derivatives markets rather than invest long-term through primary markets in the ‘real’ economy, absent any collective commitment to overhaul public infrastructure, limit destabilizing inequality, and maintain macroeconomic health on a regular basis.
Solution of collective action problems requires well-conceived and well-targeted exercises of collective agency—the things sovereigns and franchisors do.
Much of our work is devoted both to substantiating the foregoing claims and to designing the means of addressing the problems they highlight. The latter accordingly are means of bringing the public back into allocation in ways that don’t arbitrarily ‘pick winners and losers.’
In theory, the means we sketch could be adopted by central banks themselves, in effect bringing-in politics-implicating functionalities without thereby having to implicate partisan divisions. In the US context, however, institutional history and ‘path-dependence’ suggest that a new public instrumentality, operationally situated between the Fed and the Treasury, probably would be the simplest way to put allocation at the service of modulation, thereby completing the job of what we call ‘deep’ financial reform shown to be necessary by 2008.
We call our proposed institution a National Investment Authority (NIA), which, as the foregoing should indicate, is rather more than a mere ‘investment-’ or ‘infrastructure-bank.’ It would optimally bridge fiscal and monetary policy, in a division of labor apportioning more ‘purely’ political allocative questions to the former, more technical modulatory questions to the latter, and more neutral allocative questions, sounding in solutions to coordination and collective action problems, to the new institution.
Combined with our forthcoming work on both ‘fintech’ and a ‘Citizens’ Fed,’ our full body of work sketches a renewed and repurposed financial system that takes the underlying franchise nature of finance more seriously, keeps the public more fully in charge, and channels our primary shared resource —our monetized full faith and credit— more carefully toward productive not speculative uses.
For background reading, see:
Robert Hockett (@rch371 ) is Edward Cornell Professor of Law at Cornell Law School.
Saule Omarova is a Professor of Law at Cornell Law School.